Coverage of the Investment Innovation Conference

At a time when many pension plans are looking to de-risk, the last six years of stellar equity market returns have brought added pressure to re-risk in the face of mounting liability growth. That’s according to Federico Gilly, Managing Director and Senior Portfolio Manager at Goldman Sachs. He was speaking at the 2015 Investment Innovation Conference in Los Angeles in November. During his presentation, “Outcome Based Investing With Hedge Fund Betas,” Gilly explained that using alternative risk premia strategies may be a solution plans are looking for in a challenging environment.

Investors have sought to manage volatility and enhance returns through alternatives such as hedge funds. Gilly pointed to historic performance, noting that, since 2001, hedge funds have performed relatively well compared to a traditional global 60/40 portfolio, and demonstrated less volatility for the same type of return.

However, they have also exhibited high directionality to traditional assets.

“One of the biggest challenges that investors have faced is the high correlation, or high directionality, to a traditional portfolio,” Gilly explained.

He added that selecting hedge funds can also be hard due to the significant dispersion in risk-adjusted returns. “The idea that you would receive greater returns for selecting higher risk strategies hasn’t really played out,” said Gilly.

As a solution, Gilly pointed to factor-based investing, or “alternative risk premia.” Factors are rules-based strategies designed to generate attractive performance and backed by economic research. They are persistent and economically intuitive, and are efficient and investable.

Alternative risk premia are strategies that take advantage of value, momentum and carry to generate returns, said Gilly, adding that hedge fund strategies are at the core of alternative risk premia. Importantly, these strategies avoid one of the biggest downsides of hedge funds – the high correlation with traditional assets. For plan sponsors seeking to re-risk and move away from traditional asset classes, outcome-based investing using alternative risk premia may be worth exploring because, compared to traditional hedge fund portfolios, it can increase cost-effectiveness, increase liquidity and transparency, and offer diversification benefits.

At the end of the day, investors should get paid a positive excess return for investing in them. “Alternative risk premia definitely fill a role,” Gilly says.